EUROPE - The impact of the current economic crisis has resulted in closer scrutiny by many European supervisors of occupational pensions and the shared message appears to be pension funds should not over-react, the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) has said.
In its Spring Financial Stability Report 2009 on the financial conditions and financial stability of the insurance and occupational fund sector in the EU/EEA, CEIOPS said the financial turmoil had mainly impacted IORPs (pension funds falling under the EU Directive on Institutions for Occupational Retirement Provision) in their role as institutional investors.
The report noted IORPs had been hit as investors in structured credit products, while sharp drops in equity markets and increasing credit spreads had put the schemes’ investment portfolios “under severe strain”.
That said, CEIOPS stressed the impact “has not been as severe as seen in other financial sectors as the long-term nature of the liabilities affords some protection in this respect and IORPs have not experienced the liquidity problems experienced elsewhere”.
Despite this, the organisation suggested the defined benefit (DB) occupational pension fund sector is under increased pressure because of low interest rates and prevailing longevity risk, while it suggested “a careful plan design, such as suitable default options and lifecycle mechanisms, are important elements in mitigating the effect of market downturns” on defined contribution (DC) members.
The findings of CEIOPS’ research showed the financial crisis has reduced the funding levels for DB schemes across Europe so some countries - including Netherlands and the UK - were now reporting funding levels of less 100%.
The body noted some countries had implemented increased reporting requirements to the sector’s supervisor, while pension funds deemed to be higher risk are under closer scrutiny in some states, but the general message to pension funds is to be more alert without over-reacting to the crisis.
That said, the report noted the data for 2008 is “very limited at this time”, although the fall in equities is seen as the main issue in the downturn of pension funds; a view pinpointed by 12 members states as a key risk, while 10 countries highlighted interest rate and inflation as a top concern but only Greece classed accounting changes as a main risk.
While most pension schemes appeared to reduce equity weightings over the year, the research showed that in some countries, such as Italy, where the pension system is mainly DC based “there is evidence that pension funds have been net buyers of equities during 2008 and, in particular, in the fourth quarter when the crisis hit harder”.
CEIOPS said the counter-cyclical behaviour of these funds appeared to be built on the investment process, particularly the use of a benchmark portfolio such as 30% equities and 70% bonds, so that when equity prices dropped managers had to “rebalance” the investments towards the benchmark.
It noted that while this can be seen as an “automatic stabiliser” in some contexts, if the fund is large enough to influence markets, it also warned that possible drawbacks include “herding behaviour” and the possible reduction in incentives for original market research.
CEIOPS admitted it is “not possible to draw far-reaching conclusions at this stage” regarding the impact on pension funds, but said there had been a “number of common reactions to the crisis” across Europe.
It revealed: “A shared message from supervisors is that it is essential that IORPs do not over-react in the face of the downturn, but should ensure they are active and alert to potential changes in the funding level of the IORP and also health of the sponsor”.
Despite closer scrutiny by supervisors becoming a more “common feature”, alongside some modifications to the approach taken within the existing regulatory framework, it added “the current regime is seen by many as being flexible enough to cope”.
In DC-based pension systems, however, the research highlighted a need for “better disclosure to members and an emphasis on financial education and awareness”, which could be combined with “some reconsideration of the design of DC plans, in order to limit risks for members close to retirement and introduce life-cycle mechanisms”.
The next financial stability report will be issued by CEIOPS in late autumn 2009.
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